Federal prosecutors yesterday unsealed conspiracy charges against eight former KPMG LLP officials and a lawyer accused of helping wealthy clients evade billions of dollars in taxes in what authorities called the largest criminal tax fraud case in history.
The charges are expected to be the first in a wave of actions against professionals who profited from aiding high-net-worth customers shield income from the Internal Revenue Service during the economic boom, prosecutors said. The tax evasion deals, which required the participation of accountants, lawyers, investment bankers and their wealthy clients, cost the government at least $2.5 billion.
The indictment of the individuals occurred as a federal judge yesterday approved a deal to defer prosecution of KPMG itself. At a Washington news conference, Attorney General Alberto R. Gonzales acknowledged that the government had considered "collateral consequences," including the fate of 18,000 employees, in striking the $456 million pact with the accounting firm over its role in marketing the tax shelters.
"The conviction of an organization can affect innocent workers . . . and can even have an effect on the national economy," Gonzales said. The U.S. Supreme Court earlier this year reversed the criminal conviction that helped push accounting firm Arthur Andersen LLP out of business three years ago.
IRS Commissioner Mark W. Everson said the tax avoidance schemes amounted to a "direct assault" on the American tax system and enriched already wealthy clients and KPMG partners.
"Accountants and attorneys should be the pillars of our system, not the architects of its circumvention," Everson said.
The deals, which generated large paper losses for hundreds of customers between 1996 and 2002, won approval from the highest levels of the firm's tax unit -- including Jeffrey Stein, who rose to become KPMG's deputy chairman; John Lanning, former vice chairman of tax services; and Richard Smith and Philip Wiesner, former leaders of the District-based national tax division. They were among the executives each indicted on a single count of conspiracy to evade taxes.
Also charged were former KPMG partners Jeffrey Eischeid and Mark Watson, San Francisco investment advisers John Larson and Robert Pfaff, and former Sidley Austin Brown & Wood LLP lawyer Raymond J. Ruble, according to the indictment unveiled by David N. Kelley, the U.S. attorney for the Southern District of New York.
Defense lawyers for the former KPMG officials and others who were indicted asserted yesterday that their clients did not break the law and that the deals followed policy set out in the tax code and at KPMG itself. The men, who will be allowed to surrender to authorities next week, are scheduled to be arraigned by Judge Lewis A. Kaplan in New York on Sept. 6. They face a maximum of five years behind bars on the single conspiracy count.
Kelley told reporters that the investigation continues against individuals and business entities that facilitated the tax shelters, as well as those who benefited from them.
Senate reports and court cases filed by investors indicate that Deutsche Bank AG, UBS AG and HVB Group, among others, worked closely with KPMG, as did multiple law firms. Spokesman for UBS and HVB have said they are cooperating with investigators. Deutsche Bank has declined to comment. Accounting firm Ernst & Young LLP said earlier this year that it is under investigation by a federal grand jury in New York for its tax shelter sales.
A lawsuit filed by investment advisers that challenges the IRS's interpretation of one of the shelters earlier this year disclosed names of many clients who employed the deals. Those clients include hedge fund manager Edward S. Lampert, former Qwest Communications International Inc. chief executive Joseph P. Nacchio and onetime Conseco executive Gary C. Wendt, according to documents released in the California case. The men have declined to comment about the shelters in the past.
The indictment released yesterday claims that each of the defendants prepared false documents to deceive regulators about the true nature of the tax shelters. The transactions broke the law because they involved no economic risk and were designed solely to minimize taxes, prosecutors said. A small group of the KPMG officials also sought to mislead investigators at the Senate permanent subcommittee on investigations, the indictment says. The subcommittee held two days of ground-breaking hearings on the tax shelter industry in November 2003.
KPMG Chairman Timothy P. Flynn said the firm regretted taking part in the deals and sent a message to employees calling the conduct "inexcusable." The firm collected about $128 million in fees for selling tax shelters, prosecutors said. KPMG will forfeit those fees as part of the $456 million settlement. As part of the deal, KPMG admitted that one of the tax shelters it marketed was fraudulent.
Attorneys for the executives indicted said yesterday that their clients played by the rules. "If the government wants to put an end to these types of transactions, the proper response is for Congress to change the law, not to scare professionals away with indictments," said Robert S. Fink, a defense lawyer for Smith. "It is a misuse of prosecutorial discretion to use criminal prosecutions to change accepted and legitimate standards of conduct."
They also argue that KPMG abandoned its partners to save itself from criminal charges. Prosecutors and KPMG defense lawyers Robert S. Bennett and Carl S. Rauh clashed for months over the prospect of indicting the firm. Ultimately, senior Justice Department leaders decided such a move could imperil the auditing market, which is dominated by four large firms.
Underscoring the narrow choices for companies seeking an accounting firm big enough to review their books, yesterday's agreement allows KPMG to continue to audit the Justice Department itself.
Regulators at the Securities and Exchange Commission and the Public Company Accounting Oversight Board issued statements yesterday expressing confidence in KPMG's ability to perform "high quality" audits.
Staff writer Dean Starkman in New York contributed to this report.